Today we are going to look at The Estée Lauder Companies Inc. (NYSE:EL) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Estée Lauder Companies:
0.25 = US$2.7b ÷ (US$15b - US$4.6b) (Based on the trailing twelve months to September 2019.)
So, Estée Lauder Companies has an ROCE of 25%.
Is Estée Lauder Companies's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Estée Lauder Companies's ROCE appears to be around the 24% average of the Personal Products industry. Regardless of the industry comparison, in absolute terms, Estée Lauder Companies's ROCE currently appears to be excellent.
The image below shows how Estée Lauder Companies's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Estée Lauder Companies.
Do Estée Lauder Companies's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Estée Lauder Companies has total assets of US$15b and current liabilities of US$4.6b. Therefore its current liabilities are equivalent to approximately 30% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Estée Lauder Companies's ROCE
, Estée Lauder Companies shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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